In this market where fear rules, nearly all stocks are punished. With inflation sky high and the Federal Reserve tightening monetary policy in response, 2022 is sure to be one of the more volatile years for the stock market in at least the last decade. Investors should focus on companies that can easily withstand turbulence -- companies that generate lots of cash.
Three Motley Fool.com contributors think Alphabet (GOOGL -0.51%) (GOOG -0.45%), Universal Display (OLED 4.23%), and Kulicke and Soffa Industries (KLIC 1.82%) are cash cows ideally positioned to thrive. Here's why they think each is a buy right now.
The "Snap" that broke the camel's back?
Nicholas Rossolillo (Alphabet): Pretty much every business that is involved with digital advertising has been thrown into (more) turmoil in the last week. Turns out investors can add Snap (SNAP 2.24%) -- as in social media company Snapchat -- to the list of worries that already include inflation, war, and possible global economic recession. Snap, which makes money off of ads, walked back its revenue and profit guidance provided just a month ago, citing worsening macroeconomic conditions. A debate was sparked as to whether this was just a Snap problem or an indication of wider industry slowdown.
Google parent Alphabet wasn't immune to the pain. Mr. Market decided the only internet search provider investors care about is going to get hit by the same economic factors as Snap. Color me skeptical.
Sure, I wouldn't be surprised if Alphabet records a slower growth rate for the rest of the year than it did in the first quarter of 2022. For the record, revenue expanded at a 23% year-over-year pace in Q1. But with shares trading for 20 times trailing-12-month earnings (or 22 times trailing-12-month free cash flow) and just under 17 times one-year forward price-to-earnings, expectations for a slowdown look priced into the stock at this point.
And even if Google's ad and internet empire lose some steam, this is no Snap. Alphabet reported total operating income of $20.1 billion in the first quarter of 2022, an operating margin of nearly 30%. Free cash flow was $15.3 billion. Talk about a cash cow. Snap, by contrast, reported free cash flow of $106 million on revenue of $1.06 billion in Q1 -- basically, an amount that could be an easy rounding error when calculating Alphabet's results.
Add in a balance sheet featuring some $120 billion in cash and equivalents and you start to get the idea. A cyclical slowdown in digital advertising, if that is indeed what's in store later this year, is going to hit harder for just about everyone else in the digital ad industry than it is for Google.
Even more important than the cash itself is what Alphabet is deciding to do with the cash. It used $11.4 billion in share repurchases in Q1 alone, a huge return to shareholders that is further boosting the value of this money machine. Alphabet stock is now down 30% from all-time highs as of this writing. I struggle to see how this stock doesn't make investors money five years from now, so I'm blocking out the naysaying and will be buying more.
Small cash machines can also be extremely effective
Anders Bylund (Universal Display): Organic light-emitting diode (OLED) screens are showing up everywhere, from mid-range smartphones to top-shelf TV sets. Everybody knows that OLED researcher and materials reseller Universal Display is a high-octane growth stock as the technology is taking the world by storm. That's certainly true, as Universal Display has doubled its sales in five years.
But did you know that Universal Display also runs a highly efficient cash machine?
Yep, that's also true. The company pocketed $170 million of free cash flows over the last four quarters based on top-line sales of $570 million. That works out to a cash-based profit margin of 29.8%. To put that metric into context, let's compare it to one of Universal Display's most important customers: iPhone maker Apple (AAPL 0.68%) generated $84.4 billion of free cash flow and $386 billion in revenue over the same period. Hence, Cupertino's free cash margin stopped at 21.9%.
Furthermore, Universal Display's balance sheet is clean as a whistle. The company has $727 million of cash equivalents available and no long-term debt at all. It's not exactly fair to compare these figures to Apple's much larger organization, but let me just point out that the iPhone maker carries more long-term debt than cash on its balance sheet.
Universal Display may be small, but the company packs an impressive punch in terms of cash generation and ultra-safe cash-to-debt ratios. And the company is committed to returning excess cash to shareholders over time, offering an effective dividend yield of 1% today. That's actually higher than Apple's dividend yield, which sits at just 0.6%.
So when you invest in Universal Display, you're getting a relatively small company with massive growth opportunities ahead of it. The company knows how to squeeze cash profits out of its revenue streams, and it's hard to imagine a cleaner balance sheet. The cherry on top is a more-than reasonable dividend policy.
Oh, and the stock is down more than 21% over the last three months as nervous investors backed away from risky growth stocks. In other words, Universal Display is on fire sale, and there is nothing wrong with the underlying business. What's not to love?
This small cap semiconductor stock could buy all its shares back in five to six years
Billy Duberstein (Kulicke & Soffa): If we're talking cash cows and safety, the factors I like to look for are cash on the balance sheet as a percentage of a company's market cap, as well as a low valuation. Semiconductor advanced packaging-equipment company Kulicke & Soffa Industries checks both of those boxes in spades.
At the end of its quarter ended in April, Kulicke & Soffa held over $690 million in cash on its balance sheet, making up nearly 22% of its mere $3.15 billion market cap. Additionally, Kulicke & Soffa only trades at a bargain-basement valuation of just 6.8 times trailing earnings. If we strip out the cash, the stock is only trading at a 5.3 earnings multiple!
Obviously, market participants are anticipating this traditionally cyclical stock to have a downcycle at some point in the future. Of course, we are in a very hot semiconductor market right now, which has led to record packaging-equipment sales and profits for Kulicke & Soffa. However, management is also growing new product segments that could sustain revenue and cash flow at these levels once the core market cools.
While Kulicke & Soffa is mainly involved in traditional ball-bonder packaging tools, which are highly cyclical, CEO Fusen Chen has developed several new products over the past few years. These involve thermal compression bonding for leading-edge chips, miniLED and MicroLED advanced display tools, as well as auto-focused packaging tools. These are smaller segments but ones that should grow extremely fast going forward.
So, while the traditional advanced packaging sector may be above the "baseline" revenue for Kulicke & Soffa right now, management is expanding that baseline. Given the strong semiconductor market and massive capacity-buildout forecast for this year and next, above-trend sales could continue for the next couple of years. Yet by the time the cycle normalizes, newer products in advanced displays, autos, and after-market services will be much bigger. Therefore, Kulicke & Soffa could very well replicate the $1.5 billion to $1.75 billion it has generated in its past fiscal year and trailing twelve months, respectively, as well as $400 million to $500 million in net income for the next several years.
Merely maintaining today's profits without any growth would still make Kulicke & Soffa a bargain. At these profit levels, it would only take five years for management to repurchase basically all of its stock. And that brings me to the last bit of good news: The traditionally conservative Kulicke & Soffa management has just cranked up share repurchases as the market fell this year. The company recently completed an accelerated share-repurchase program for $150 million in March, which quickly retired 4% of the company's stock.
That is a significant step-up in repurchase activity relative to the recent past. The repurchases should continue for the rest of this year, given that there was still $340 million left in the company's authorization as of the end of April, and the stock continues to trade at a very low valuation.
A higher-inflation environment without a bad recession could cause value stocks to come back into fashion relative to growth. If so, Kulicke & Soffa is an under-the-radar cash cow to add to your portfolio today.